Tuesday, November 15, 2016

Canada Courts Big Funds on Infrastructure?

Justin Trudeau is billing Canada as a stable option for international investors amid market uncertainty in the aftermath of the election of Donald Trump in the United States.

Speaking at the end of a day spent courting some of the world’s largest wealth managers, the Prime Minister added a clear political spin to his government’s pitch that investors should be working with Ottawa on infrastructure projects.

“The fact is Canada is lucky to have citizens that are forward-thinking, that are reasonable, that are understanding that drawing in global investment will lead to good Canadian jobs,” he said.

Mr. Trudeau said Canada is attracting attention from people who wonder how the country remains open to investment, trade and immigration during a period of uncertainty, making reference to the “election of the Republican candidate in the United States” without naming Mr. Trump.

Mr. Trudeau is encouraging banks, pension funds, insurance companies and private wealth funds to take equity stakes in Canadian infrastructure projects through a new Canada Infrastructure Bank announced this month. Advocates say such a bank could group public and private funds together for large projects, allowing more construction to proceed more quickly.

Politics aside, some of the investors in attendance gave the government’s presentation an enthusiastic response.

Mark Machin, chief executive officer of the Canada Pension Plan Investment Board, was among the roughly two dozen Canadian-based investors who met Monday morning with Mr. Trudeau and senior ministers to discuss infrastructure spending.“It’s a terrific initiative,” he said in an interview at the CPPIB’s Toronto headquarters following the meeting. Mr. Machin said the infrastructure plan should “absolutely” attract new money from institutional investors because the bank will offer firms a single point of contact and is promising to do the advanced research in order to prioritize infrastructure projects that are good candidates for private partnerships.“I would think if this gets off the ground the way it should, then it should result in significant increase in activity in infrastructure,” he said.

The CPPIB announced earlier this month that the assets of the CPP fund have climbed above $300-billion as of Sept. 30, which is up from $287.3-billion the year before.

The CPP fund has just one current investment in Canadian infrastructure: a 40-per-cent share of Ontario’s 407 toll highway, which runs through the Greater Toronto Area.

Mr. Trudeau also met Monday with global wealth managers in the afternoon, among them representatives from BlackRock Inc., which is the largest asset manager in the world.

Executives from the country’s largest banks, pension funds and insurance companies said Monday morning’s meeting affirmed the government’s commitment to developing its infrastructure plan, but several attendees said it was short on details of what the planned infrastructure bank would look like.

Ministers representing the departments of Finance, Transport, Natural Resources and Infrastructure and Communities outlined the types of infrastructure deals and projects that are most interesting to the government. Some executives offered thoughts on what made certain infrastructure deals work well in other parts of the world, and they suggested different investment structures that could work for building new projects such as pipelines and electricity transmission.

“I believe that they have a vision to put together a model which is pretty ground-breaking,” said Ron Mock, chief executive officer of the Ontario Teachers’ Pension Plan, after the session. He noted that private funding models exist in Britain, Australia and Mexico and that Canada could be a leader with its plan. “In terms of the details of how it will actually be executed, I think they are correctly looking to the expertise that exists in the country for input and advice on how to move this agenda forward.”

Attendees characterized the meeting as an early step in gathering input and support for the part of the government’s planned $180-billion spending spree that is counting on an influx of private capital. But some said they were hoping there would be more clarity on what happens next, rather than being asked for another round of input on how to make the plan work.

During the session, the group discussed the widespread interest in so-called “brownfield” assets – where investors buy and operate existing infrastructure, rather than taking on the risk of constructing new projects from scratch. The government has expressed more interest in using private capital in building new infrastructure projects, called “greenfield.”

Questions about how the federal government would align its objectives with the provincial and municipal governments that traditionally control a lot of infrastructure spending were also top of mind for many participants. Constructing new infrastructure where users must pay fees or tolls may be a tricky sell to these lower levels of government and their constituents.

“Clearly the execution of this becomes important, and that in many cases requires the federal, provincial, municipal alignment, which is which is pretty key,” Mr. Mock said. “Because most infrastructure in this country is either provincial or municipal and it’s the federal government that is wanting to initiate such a plan.”

Prime Minister Justin Trudeau pitched fund managers from around the world on the merits of investing billions in Canadian infrastructure projects Monday, earning praise from some but leaving others with questions about how such deals would work.

Ottawa is setting up a new entity — the Canada Infrastructure Bank — to promote large national and regional projects, including revenue-generating ones it hopes will draw the interest of big institutional investors, including domestic pension funds.

Monday’s meetings in downtown Toronto — a morning session with Canadian pension funds managers and top bankers, and an afternoon discussion with international investors — brought the prime minister and key cabinet ministers face-to-face with some of the money managers they will need to attract to make the bank a success.

Ron Mock, chief executive of the Ontario Teachers’ Pension Plan, said Trudeau and his cabinet have “got their head in the right place” in creating projects that would draw on government money and investment from institutions, such as pension funds.“They did a great job,” Mock said as he left the morning meeting, which also included Trudeau, Finance Minister Bill Morneau and top representatives from the Caisse de dépôt et placement du Québec and the Canada Pension Plan Investment Board.

But Hugh O’Reilly, chief executive of the Ontario Public Service Employees Union Pension Trust, said many details needed to be ironed out.“We still have many questions about how this infrastructure bank will work,” he said. “But the federal government acknowledged that — and are looking to pension funds to provide advice.”

The plan, which has $16 billion in assets, will look at opportunities case by case, he added.

After the meeting, Trudeau said he was “tremendously pleased to see so many business leaders at the table.”

“We know that partnerships with the private sector can be done right, and we look forward to working with these significant global investors to see how we can make sure we’re responding to their needs,” he said.

His government has pledged $81 billion over the next 10 years for infrastructure, including public transit and renewable power projects. The first $15 billion will become available in the spring 2017 budget.

A spokesman for the Canada Pension Plan Investment Board called the talks “constructive.”

The Canadian Infrastructure Bank should offer “an intelligent bridge between what investors are looking for and what governments can offer. (CPPIB officials) look forward to seeing the pipeline of potential infrastructure investments.”

The prime minister said he hoped the bank would “be up and running in 2017, but we’re also working very, very hard with experts and listening to people to make sure we get it right.”

Earlier Monday, a few blocks from the Trudeau meeting, Marc Garneau, the transportation minister, told another group of investors Ottawa’s recently announced $10.1-billion funding commitment to upgrade trade transportation corridors does not depend on participation by the private sector.

Garneau said he expects there will be interest from the public–private partnerships to invest in the trade transportation improvements. But even if there isn’t, the federal government will go ahead with the spending.“The funding is there,” Garneau said in a brief interview after his speech at a conference organized by the Canadian Council for Public-Private Partnerships, which attracted about 1,200 investors, project proponents and governments from around the world.

“If there is not large institutional investors that want to become involved with it, we will still be using the money, as I said in my speech, to reduce bottlenecks and congestion and make our trade transportation corridors as efficient as possible.”

Morneau announced the $10.1 billion in trade transportation funding in his fall fiscal update this month. The trade corridor upgrades are part of a massive boost in planned infrastructure spending.

Garneau said improving transportation corridors is so important for Canada’s trade, it won’t need to wait for private funding. About one-fifth of Canadian goods is shipped by rail, and much of that is destined for export.

Transportation volumes are increasing. Over the past 30 years, the amount of goods moved by rail has increased 60 per cent, while the amount shipped by sea is up 40 per cent.

The $10.1 billion in funding is designed to remove bottlenecks that are slowing traffic on important export corridors.

That doesn’t mean the government is not interested in encouraging private-sector involvement. The new infrastructure bank is intended to foster private investment in projects.

Canada's Liberal government is speaking to sovereign wealth funds and global private equity firms as well as domestic pension funds as it ramps up efforts to attract funding for its new infrastructure bank, according to two sources.

The overseas investors that the officials developing the infrastructure bank are speaking to include the Government Pension Fund of Norway, one of the world's largest sovereign wealth funds, said the sources, who declined to speak on the record because of the sensitivity of the talks.

The government said earlier this month it would set up an infrastructure bank and give it access to C$35 billion ($26 billion) to help fund major projects.

Prime Minister Justin Trudeau and Finance Minister Bill Morneau are attending an event in Toronto on Monday aimed at attracting private investment. The event is part of a series of meetings with private investors ahead of the launch of the bank, which Ottawa hopes will be up and running next year, the sources said.

Trudeau and Morneau had previously expressed a desire to attract investment from Canada's biggest pension plans such as the Canada Pension Plan Investment Board (CPPIB), the Caisse de depot du Quebec and the Ontario Teachers' Pension Plan.A significant proportion of the projects the bank hopes to fund will be built from scratch, known as "greenfield" investments, rather than "brownfield" investments which have already been built.

The Canadian pension funds, among the world's ten biggest infrastructure investors, have invested more in projects overseas than in their domestic market.

That is partly because they have preferred to invest in existing infrastructure which has established revenue streams and does not carry construction risk. However, that stance is changing as investors seek alternatives to government bonds and volatile equity markets.

Last week, CPPIB's Chief Executive Mark Machin said in an interview the fund would be open to investing in greenfield projects through the infrastructure bank.

Meanwhile, the Caisse, Quebec's public pension fund, is planning to build a new 67 kilometer public transit system in Montreal, investing C$3 billion and seeking to supplement that with C$2.5 billion of federal and provincial government funding.

That project could be one of the first to be funded by the new infrastructure bank, the sources said.

Sources said the Ontario Teachers Pension Plan is also planning to invest more in greenfield projects.

Before I start covering the latest developments on Canada's infrastructure program, I want to correct an error I made last week when I posted that Bert Clark, the former head of Infrastructure Ontario, left that agency to head up the newly created Canadian Infrastructure Development Bank (CIDB).

It turns out that Mr. Clark is Ontario's new pension leader, now in charge of running the newly created the Investment Management Corporation of Ontario (IMCO). As of now, the federal government has not named a leader for Canada's new infrastructure bank. I can suggest a few people, including Bruno Guilmette, the former head of infrastructure at PSP Investments (not sure he wants this job but he is more than qualified and has the right connections) or even Michael Sabia whose term at the Caisse is coming to an end and who along with Mark Wiseman, sat on the Advisory Council on Economic Growth, and knows the issues first-hand.

In that comment, I went over concerns on governance and ended it with an update sharing some excellent insights from Andrew Claerhout, Senior Vice-President of Infrastructure & Natural Resources at Ontario Teachers' Pension Plan who responded to Chas's comment at the end of the Benefits Canada article:

Andrew told me that OTPP, CPPIB, OMERS and the rest of Canada's large pensions are not interested in small DMBF/ PPP projects which are typically social infrastructure like building schools, hospitals or prisons. Why? Because they're small projects and the returns are too low for them. However, he said these are great projects for construction companies and lenders because you have the government as your counterparty so no risk of a default.

Instead, he told me they are interested in investing in "larger, more ambitious" infrastructure projects which are economical and make sense for pensions from a risk/ return perspective. In this way he told me that they are not competing with PPPs who typically focus on smaller projects and are complimenting them because they are focusing on much larger projects.

Here is where our conversation got interesting because we started talking about Australia being the model for privatizing infrastructure to help fund new infrastructure projects. He told me that while Australia took the lead in infrastructure, the Canadian model being proposed here takes it one step further. "In Australia, the government builds infrastructure projects and once they are operational (ie. brownfield), they sell equity stakes to investors and use those proceeds to finance new greenfield projects. In Canada, the government is setting up this infrastructure bank which will provide the bulk of the capital on major infrastructure greenfield projects and asks investors to invest alongside it" (ie. take an equity stake in a big greenfield project).

Andrew told me this is a truly novel idea and if they get the implementation and governance right, setting up a qualified and independent board to oversee this new infrastructure bank, it will be mutually beneficial for all parties involved.

In terms of subsidizing pensions, he said unlike pensions which have a fiduciary duty to maximize returns without taking undue risk, the government has a "financial P&L" and a "social P & L" (profit and loss). The social P & L is investing in infrastructure projects that "benefit society" and the economy over the long run. He went on to share this with me. "No doubt, the government is putting up the bulk of the money in the form of bridge capital for large infrastructure projects and pensions will invest alongside them as long as the risk/ return makes sense. The government is reducing the risk for pensions to invest alongside them and we are providing the expertise to help them run these projects more efficiently. If these projects don't turn out to be economical, the government will borne most of the risk, however, if they turn out to be good projects, the government will participate in all the upside" (allowing it to collect more revenues to invest in new projects).

He made it a point to underscore this new model is much better than the government providing grants to subsidize large infrastructure projects because it gets to participate in the upside if these projects turn out to be very good, providing all parties steady long-term revenue streams.

Basically, Andrew Claerhout explains why pensions are not competing with DBFM/ PPPs and are looking instead to invest alongside the federal government in much larger, more ambitious greenfield infrastructure projects where they can help it make them economical and profitable over the long run.

Andrew added this: "Most infrastructure investors focus on brownfield
opportunities while the government is most interested in seeing more
infrastructure built (i.e., greenfield). The infrastructure development
bank is meant to help bridge this divide - hopefully it is successful."

As the Reuters article mentions, OTPP is open to investing in greenfield infrastructure projects of which the first one to likely be funded by the new federal infrastructure bank is the Caisse's new 67 kilometer public transit system in Montreal.

Prime Minister Trudeau and Finance Minister Morneau pitched their new infrastructure program to Canada's large pensions but also to sovereign wealth funds like Norway's Government Pension Fund and Blackrock, the world's largest asset manager where Mark Wiseman now works.

The thing that is a bit confusing is that typically large pensions and sovereign wealth funds invest in "brownfield" infrastructure which is already operational with known cash flows, but the federal government is not looking to sell stakes in Canada's existing airports or ports which it owns.

Instead, the newly created Canada Infrastructure Bank will partner up with Canada's large pensions and other large global funds to invest in greenfield projects which carry a whole new set of risks.

Can this be done successfully? Of course, and some of Canada's large pensions like the Caisse have already begun working on greenfield projects and they have the internal resources to complete such ambitious projects.

When I mention the right internal resources, let me be very clear. Macky Tall, the head of CDPQ Infra, has assembled an outstanding team full of people with actual project finance and operational experience in large infrastructure projects. These people previously worked at large engineering/ construction companies like SNC-Lavalin and other places where they had to handle budgeting, building and operating large greenfield infrastructure projects.

I'm going to be very honest here, Canada's large pensions have made outstanding "brownfield" infrastructure investments all over the world but nobody has assembled a team like that at CDPQ Infra to handle the risks and complexities that go along with greenfield projects.

In fact, when it comes to direct infrastructure and real estate investments, CDPQ Infra and Ivanhoé Cambridge, the Caissse's real estate subsidiary, are truly on another level in terms of operational expertise.

Interestingly, I had a brief chat with Hugh O’Reilly, CEO of OPTrust, this morning in the midst of writing this comment and asked him why he said many details needed to be ironed out on this new infrastructure program.

Hugh repeated that there are a lot of questions on how the federal infrastructure bank will operate but the government is going to address these concerns. He also said the federal government needs to reach out to public-sector unions to address their concerns, "just like the Caisse did."

He also told me that OPTrust's alternatives portfolio is growing and they are investing more and more directly in private equity, real estate and infrastructure. I will cover OPTrust in detail in a future comment and thank Hugh for taking the time from his busy schedule to speak with me (extremely nice man, would like to spend more time with him and James Davis, OPTrust's CIO, to understand their investments and operations).

Let me end my comment by stating that even though there are a lot of details that need to be worked out, there is no question in my mind that Canada has the requisite expertise to make a successful partnership between the new Infrastructure Bank, Canada's large pensions and foreign investors interested in investing in large greenfield infrastructure projects.

Importantly, if Canada's new infrastructure program is successful and they get the governance right at the Canadian Infrastructure Development Bank (CIDB) , it will be a new unique approach to investing in greenfield infrastructure unlike anything else in the world. It will set a new global standard, one that many countries will try to adopt, including the United States where I really believe a Trump administration needs to approach US, Canadian and global pensions to "make America great again" (Trump's plan to rebuild America will be a lot harder to pay for than it sounds).

Lastly, please pay no attention whatsoever to Terence Corcoran's latest, The Liberals’ new ‘infrastructure bank’ is pure central planning at its worst. I'm tired of addressing the drivel coming out of the National Post from the likes of Andrew Coyne and Terence Corcoran who quite frankly haven't the faintest idea of good governance, investing in infrastructure, and why this plan makes sense for the federal government, Canada's large pensions, their members and stakeholders, Canadian taxpayers and most important of all, for the Canadian economy over the long run.

If you want to understand why the new infrastructure bank being proposed makes perfect sense, take the time to carefully read a Globe and Mail op-ed by Michael Sabia and Mark Wiseman, Private infrastructure bank will put Canada on a path to growth. Unlike others, they actually know what they are talking about when it comes to infrastructure.

Lastly, $21-trillion worth of foreign funds descended on Toronto yesterday as Prime Minister Justin Trudeau pitched Canada to the world. Dominic Barton, Chair of the Advisory Council for Economic Growth, tells BNN he's never seen anything quite like this in Canada (click here to view it if it doesn't load below).

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I am an independent senior economist and pension and investment analyst with years of experience working on the buy and sell-side. I have researched and invested in traditional and alternative asset classes at two of the largest public pension funds in Canada, the Caisse de dépôt et placement du Québec (Caisse) and the Public Sector Pension Investment Board (PSP Investments). I've also consulted the Treasury Board Secretariat of Canada on the governance of the Federal Public Service Pension Plan (2007) and been invited to speak at the Standing Committee on Finance (2009) and the Senate Standing Committee on Banking, Commerce and Trade (2010) to discuss Canada's pension system. You can follow my blog posts on your Bloomberg terminal and track me on Twitter (@PensionPulse) where I post many links to pension and investment articles as well as my market thoughts and other articles of interest.

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